Monday, October 24, 2011

A "Grande" Idea - Let People Profit From Crowdfunding

Starbucks' recent announcement that it will start taking donations from its tens of millions of customers to help fund small businesses was a grande - no, make that venti-sized - idea. As the NY Times' Joe Nocera explained in his recent op-ed, "We Can All Become Job Creators," Starbucks will act as the middleman, passing along the donations to the Opportunity Finance Network, a group that represents 180 community development financial institutions (CDFIs), which lend to communities underserved by traditional banks. 

With tight credit still holding back many small businesses that might otherwise expand and hire, Starbucks and its CEO Howard Schultz have been rightly praised for this innovative program. It will be interesting to see how many caffeinated customers step up to become small business donors, or "Americans helping Americans," as the wristband they will receive for donations of $5 or more reads.

If the experience of sites like Kiva, Kickstarter and IndieGoGo is any indication, there is a lot of pent up desire among Americans to help out entrepreneurial ventures that they care about. Kiva allows people to make small loans to micro-entrepreneurs around the world and in cities like Detroit, while the other two sites are a conduit for donations to artists and entrepreneurs, such as musicians and filmmakers. Kiva has facilitated nearly $250 million in loans from more than 600,000 individuals, and Kickstarter users are pledging funds at a rate of $2 million a week.

That's impressive. But to really crack the small business capital market open, we need to make it part of the mainstream financial landscape. In other words, let people earn a profit on their money. Donations and no-interest loans are great and have helped a lot of people, but they cannot serve the vast demand for small business capital in this country. That's why I advocated in my own recent NY Times op-ed for changes to our securities regulations that would allow businesses to raise funds from many small investors—a practice known as crowdfunding.

As I wrote in that op-ed:
[Crowdfunding is] the sort of person-to-person (or P2P, in industry jargon) funding that characterized financial transactions for millennia, before our mediated, securitized financial system took holdCrowdfunding has the sort of populist, common-sense appeal that resonates with free-market libertarians and champions of the working class alike. By marrying online social networks with finance, crowdfunding offers a more democratic model of finance, in which individuals can directly fund other individuals or businesses that they deem worthy, without going through a bank or Wall Street middleman. 
Unfortunately, in this country, it's illegal to raise funds this way in return for a profit. Once a financial return is promised or implied, the offering becomes a security in the eyes of the Securities & Exchange Commission (SEC) and the legal hurdles go way up—putting public capital out of reach for most small businesses.

The laws, put into place after the 1929 stock market crash, were intended to protect investors from unnecessary risk. But the effective result is this: wealthy investors can invest in pretty much anything they like: private equity, hedge funds, venture capital. But ordinary investors (the 99%, you might say) must stick to publicly traded securities.

The problem is, most small business can generally not afford to go public—consider that the median IPO size was $140 million in 2009, up from $10 million twenty years ago! Nor do many want to, given the market volatility and Wall Street's fixation with short term results. (There is also a certain irony to this. In order to protect "unsophisticated" investors, the SEC confines them to the public markets. How safe do you feel about your stock market investments these days?)

So, no surprise, the financial landscape today is dominated by big business investment options. Think about your 401K (if you are fortunate enough to have one of those employer-sponsored plans). These plans offer a menu of funds that invest in the stocks and bonds of large companies (even a "small cap" firm falls between $50 and $300 million—the size of a large cap in the 1980s!). There may be some government bond or emerging market funds thrown in as well. But what you will not find is a small or local business fund. Those things do not exist.

Eight decades after the legal framework of securities law was put into place, the Internet and social networks have transformed the way we do everything, and the regulations look wildly anachronistic. And the vast majority of Americans are prohibited from investing in small and local businesses they want to support, and these firms in turn are cut off from a huge pool of badly needed capital.

That's why there is so much excitement about the growing bipartisan support for a crowdfunding exemption. President Obama has championed crowdfunding through his Startup America initiative, and House Republican Patrick McHenry has drafted a bill that is winding its way through the House. There are also grassroots petitions calling for a crowdfunding exemption before the SEC. The proposals vary in their details, such as the caps on the amount individuals could invest in each deal, but all would allow ordinary investors to put small sums of money in small businesses without requiring the business to go through a long and costly registration process with the SEC.

Yes, small businesses can be risky, but the small sums involved would ensure that no single investor could lose the farm on an investment. And here at Locavesting Central, we believe that community-based crowdfunding—where businesses are reaching out to their customers, neighbors and supporters— would further mitigate the risk. That's because local business owners have a reputation in the community, and potential investors have a greater knowledge of the company and the market it operates in—a key concern of the SEC. (ProFounder, an interesting crowdfunding startup in Los Angeles, is promoting such a "community-funding" model). What's more, I believe that this kind of investing—where individuals have a literal stake in their local businesses and therefore their communities—can help in the renewal of democracy and civic engagement. 

Of course, there is no guarantee that anything will come of these crowdfunding proposals, that's why it is so important to speak up. So sign the petitions (links below), call your elected representatives, and drop a few coins in the donation can at Starbucks.

  • The Sustainable Economies Law Center has filed a petition with the SEC that would allow individuals to invest up to $100 in small companies. Details, including how to post a comment with the SEC can be found here
  • Startup Exemption is another campaign to change the law—add your signature here


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